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Start family ownership transition before things get dicey

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Families that don't take the time to write, discuss and agree on a succession and transition plan are almost always destined to meet with heartache.

Misunderstandings, disagreements and unintended consequences litter the highway of poorly executed family succession plans.

Here is a case study: The father, who owns 100 percent of the business, is in his late 50s and has some life insurance. He has an inflated view of the business value, although the business is doing well and is profitable.

The father and his son have had “discussions” that they will work together for another seven years. Then, the son will buy the business and basically fund his father's retirement with a 10-year note.

As in all too many cases, this plan is mostly dad's blueprint, because they have only talked in circles about the topic.

It is important to note, 50 percent of all exits are not voluntary. Life is inherently messy.

Just like the guy in the Allstate commercials, things come along and create “mayhem.” Would your business (and family) survive the 5 D's?

Death – Who is going to run the company if you don't show up tomorrow? Will employees stay? Will the bank continue to support the business?

Disability – Will the company keep running profitably if you can't work?

Divorce – It happens. Will the impact ripple out beyond the immediate family to affect the lives of your employees?

Distress – Loss of a key customer could decrease your business value by 50 percent or more.

Disengagement – The No. 1 reason owners want to get out is burnout. Can you afford to exit?

In the case study, if the father died now, the plan is for the company to buy 100 percent of his stock with life insurance proceeds from the policy on the father's life.

In the event of the father's death, the plan was for the mother to have sufficient assets to live for the rest of her life.

However, if the company buys the father's stock under existing ownership, the mother has both the life insurance proceeds and the company, which doesn't sound like good estate planning. The mother would have liquidity, and the son would be in a position of having to buy the company from her.

This result would be unfavorable to the son and would create unplanned estate-tax issues for the mother.

What's more, the son is in a position of having to buy 100 percent of the company at a point when already he should have a significant interest in it.

The first thing is to get the son into a significant ownership position, now. The father might consider gifting or selling stock — say 20 percent — to the son.

If the father works another seven years, the son would be working with him as a co-owner. That would increase the likelihood of retaining the son's interest over the period, and he would have a leg up on any future purchase.

In the event of the father's death in the interim, if the company repurchased his shares, the son's 20 percent of the shares would become 100 percent of the shares then outstanding.

Life insurance proceeds would flow to the mother, and the son would have the company, fully paid for, affording flexibility to help the mother, as necessary.

By slightly modifying the father's plan, transferring some stock to the son, the potential for long-term success for management and ownership transition increases dramatically.

This modification would engage the son as an owner and would provide protection against unintended consequences.

That one little modification, providing the son with a significant ownership interest today, would help prove or disprove the father's long-term plan.

The father's initial plan was really just a hope and a prayer. It wasn't written, communicated or funded properly. It left the son completely in a lurch and risked his chances to succeed his father.

The proposed plan provides benefits for the father, son, company and mother. A reasonable plan that is written, well executed and adjusted over time is far better than no plan and mere hope.

But you have to start. If you don't get things in writing and communicate with your family, everything you have worked so hard for is up for grabs.

Get started. Otherwise, mayhem awaits.

Tom Garrity is managing partner of Compass Point Consulting LLC in Bethlehem. He is a certified coach with Gazelles International and a certified exit planning adviser with the Exit Planning Institute. Compass Point provides growth and business transition consulting to small- and medium-sized businesses. He can be reached at 610-336-0514 or tgarrity@compasspt.com.

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